Accounting Folks.

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I'm stuck on this question and if you could just guide me in right direction I will be appreciated. I'm keep it short and you shouldn't need more information, if you do just ask.

If a company issued convertible bonds in 2008 that cannot be converted into common stocks until September of 2011, and the question asked me to compute the proper earnings per share for 2010. So my question is, do I have to show the potential diluted EPS in 2010 even though the potential to dilute EPS will not occur until 2011? Or do you only show the potential diluted effect in 2011 when the securities can be converted into common stock?

My book isn't very clear it only states "The if-converted method assumes: 1) the conversion of the convertible securities at the beginning of the period (or at the time of issuance of the security, if issued during the period), and 2) the elimination of related interest net of tax."

I can't tell if that means you must dilute EPS as long as the security is outstanding (regardless of when it can be converted) or you dilute EPS in the period in which securities are now available to be converted. In my problem the diluted security was not issued during 2010 (question asked proper EPS for 2010) nor is it available for conversion.

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The only information I have is what I said above about the "if-converted" method. While this is a complex capital structure and it says "a capital structure is complex if it includes securities that could have dilutive effect on earnings per common share. A compelx capital requires dual presentation of EPS for both basic and diluted EPS." But the whole "if-converted" method assumption is screwing with my head. 4/5 problems I have to do is screwing with my head. They're nothing like homework problems. It's ridiculous.

The tricky part of the calculation is, if the security cannot be converted until 2011, that means in the calculation I cannot add back the interest the company does not pay on the bond since it has or does not have potential to convert into common stocks during 2010. The bondholders cannot convert to common stock, so why would it have any dilutive effect? Even if it still has to be shown, then I may have to skip adding back interest and all that other tricky calculation because the company still going have to pay interest on bond in 2010 regardless if anyone converts in 2011..

These problems are messing with my head and I can't get a straight forward clarification from the book.

The answer to your original question resides within the pages of GAAP. Unless schools have changed dramatically since I was there, the only confusion should be in searching that data base to find it. Back in the days when I had hair, (it was also dark then too) all assignments were based on one of three accounting/taxation "Bibles". GAAS, GAAP and the IRC give a sometimes not to simple explanation of what is acceptable, but they are THE authority by which all your work should comply. Class work should mirror the work you will do after graduation.

In this case you have an accounting question, which in turn is covered in GAAP. As you stated, the information you found only says "If converted". As your's are not, then half your battle is over. You'll only need to look into how to treat the bonds correctly. You may also wish to research disclosure within the financial statement's notes. This would be the place to expand on some of the other things that may or may not happen in the future.